Financial Performance Of Microfinance Institutions Of India

Delhi Business Review X Vol. 11, No. 2 (July - December 2010)FINANCIAL PERFORMANCE OF MICROFINANCEINSTITUTIONS OF INDIASECTIONAL STUDYA CROSSCROSS-SECTIONALPankaj K. Agarwal*S.K. Sinha**FOR a country like India, poverty remains to be one of the biggest policy concerns. Amongstvarious measures to eradicate it, Microfinance, of late, has provided a ray of hope. The TaskForce on Supportive Policy and Regulatory Framework for Microfinance constituted by NABARDdefined microfinance as “the provision of thrift, saving, credit and financial services and products ofvery small amount to the poor in rural, semi-urban and urban areas for enabling them to raise theirincome levels and improve their standard of living” (Sen, 2008).In numerous studies done across the world, it is generally believed that various microfinance initiatives have been able to make a difference in the target population’s lives. However, increasing doubtshave been raised over the financial sustainability of microfinance institutions. MFIs need to be economically viable and sustainable in the long run but economic implications of long termsustainability are not being considered (Srinivasan et al., 2006).At least in India, there does not seem to be any working model of analyzing the financial performanceand thereby sustainability of microfinance institutions. This problem is compounded by the absenceof a dedicated legislation on working and management of microfinance institutions. The lack of aregulatory mechanism for financial disclosures by microfinance institutions also abets the problem.The present study is an attempt to analyze the financial performance of various microfinance institutions operating in India. It assumes significance because it is imperative that these institutions be runefficiently given the fact that they are users of marginal and scarce capital and the intended beneficiaries are the marginalized sections of society. MFIs must be able to sustain themselves financially inorder to continue pursuing their lofty objectives, through good financial performance.Key Words: Microfinance, Financial Sustainability.IntroductionOf late many government, businessmen and academicians alike have shown great interest in microfinance for its potential role in poverty alleviation activities. Microfinance Institutions have been expected to reduce poverty, which is considered as the most important development objective (WorldBank, 2000). Robinson defines Microfinance as small-scale financial services for both credits and deposits – that are provided to people who farm or fish or herd; operate small or micro enterprises wheregoods are produced, recycled, repaired or traded; provide services; work for wages or commissions; gainincome from renting out small amounts of land, vehicles, draft animals, or machinery and tools; and toother individuals and local groups in developing countries, in both rural and urban areas (Robinson,2001). Subsidized credit has long been believed to be the panacea for the eradication of poverty for decades***Research Fellow, XLRI, Jamshedpur, India.Head, Department of Financial Studies, VBS Purvanchal University, Jaunpur, India.37

Pankaj K. Agarwal and S.K. Sinhanow. But perhaps the only thing subsidized credit could create was Non Performing Assets (NPAs).The realization that the core issue for the poor was access to credit rather than the cost of credit camevery late. Microfinance is often credited with putting an end to the interest rate debate for the poor.A host of players have entered microfinance space, each having a reason of its own. It is believed that,Microfinance, unlike other developmental efforts, gives quick and tangible results (Srinivasan et al.,2006). Many NGOs that were early entrants gradually metamorphosed into full fledged lenders, developmental professionals left their cushy careers to set up microfinance firms. Even many banks haveexperimented with working exclusively with self help groups and therefore have ‘microfinance branches’.The players range from not-for profits organizations trying to achieve developmental objective throughmicrofinance to commercial banks that view microfinance as ‘good, sound banking’, a good source ofdeposits, and low-risk mass lending. In fact the success of self help groups in microfinance led many touse them to achieve many other objectives as well. Many governmental schemes are being routedthrough microfinance, including a very large project funded by the World Bank and being implementedin a southern state of India. Similarly organizations like Hindustan Lever has looked at the potentialof these groups as a channel for retailing and has launched a program called ‘Project Shakti’ to tap thesmaller villages through the micro-credit. They are also being harnessed as an alternative distributionchannel. This amounts almost to free riding since these channels have been developed by the MFIsafter a lot of persistent hard work and investment. The companies that initiated this are reputed oneslike HLL, EID Parry and Philips etc. (Srinivasan et al., 2006).The persons engaged in championing microfinance are gaining prominence and it is said that some ofthe leaders, including many women, have been playing a more active role in other social spheres, to theextent of contesting elections for the panchayat and so on.Conceptual FrameworkAs microfinance firms are viewed predominantly as instruments of social change, their performancehas been often measured by non-financial parameters. The concept of social performance has seemed toovershadow the state of financial health of these enterprises. However, the accepted criteria in a number of studies to study the performance of any MFI have been the twain of Financial Performance andOutreach (Chaves and Gonzales-Vega 1996, Ledgerwood 1999, Yaron, 1992, Yaron 1994, Yaron et al.,1998, as cited in Arsyad, 2005). However, there exist various social performance assessment tools andinstitutionalized rating processes but assessment of financial performance has yet to gain ground.Some of the more popular tools include MFC Social Audit, ACCION SOCIAL, USAID SPA Audit, MCRIL, Micro-finanza Rating, Micro Rate (SPA), CGAP-Grameen-Ford Progress out of Poverty Index(PPI) etc. (Sen, 2008). These tools often focus on outreach indicators. Outreach indicators are considered as proxies for impact of MFI on development (Yaron el al., 1997).The financial performance assessment is devoid of such a multitude of options and methodologiesdespite critical importance of financial sustainability. Though an ambition for sustainable institutionshas been often articulated, there was also an opinion that most microfinance institutions working inthis field have been unsustainable (Copisarow, 2000 as cited in Dayson et al., 2006). Research studieshave shown that this is predominantly connected to the perception of micro borrowers’ risk and creditworthiness, and the diseconomies of scale in making small loans (Quach, 2005, As cited in Dayson etal., 2006).Microfinance has been attractive to lending agencies because of demonstrated sustainabilityand low cost of operations. In India, the engagement of NABARD and SIDBI shows that they see longterm prospect for this sector (Srinivasan et al., 2006).However, the methodologies to study financial sustainability are fewer. Review of studies reveal thatamongst those available, most of the tools available cover social as well as financial performance.Principal among them are CAMEL model by ACCION, PEARLS model by WOCCU, GIRAFE Ratingby PlaNet and MicroRate (CGAP, 2001 as cited in Arsyad, 2005). Amongst these, except the PEARLSmethodology by World Council of Credit Unions (WOCCU), all others are hybrid models using bothqualitative and quantitative data (Arsyad, 2005). These methodologies are proprietary and not available for use in public domain.38

Delhi Business Review X Vol. 11, No. 2 (July - December 2010)It is noted with surprise that in India, a review of the studies done on microfinance sector has revealedthat there is hardly any study focusing on the financial health of MFIs.It seems this is due to the branding and common perception of MFIs as not for profit organizations.However the long term viability of any business model depends as much on the financial viability as onits ability to deliver its avowed objectives.It can be seen that without sound financial performance the sustainability of these microfinance institutions is not possible. Increasingly questions are being raised over the cost of funds for these enterprisesand their ability to earn margins sufficient to cover their operational costs and still leave some profit(Arsyad, 2005). It has been pointed out repeatedly that MFIs need to be economically viable and sustainable in the long run (Srinivasan et al., 2006). In fact studies have found strong linkage between thefinancial sustainability of microfinance institutions and achievement of their social objectives. Lowincome customers are more likely to borrow from institutions they see as financially viable (Zeller etal., 2003).The extant business model of most of the MFIs involves huge operational costs since a lot of contact isrequired with the intended beneficiary. Also as for as the cost of funds are concerned, as the scale ofoperations goes up, MFIs need funds beyond the grant/soft loans etc. The commercial funding requiresthem to have risk capital with market interest rates.In this backdrop the sustainability of MFIs needs to be looked at very carefully even from a socialperformance standpoint. The results achieved in poverty alleviation by MFIs can not be an event andgiven the endemic nature of poverty, requires a continuous and long term commitment from theseenterprises.Morduch (1999) as cited by Crabb (2008), describes the need for more empirical work on the sustainabilityof MFIs. He points out: “Empirical understandings of microfinance will also be aided by studies thatquantify the roles of the various mechanisms in driving microfinance performance .” The presentstudy attempts to analyze and compare the financial performance of the MFIs primarily from asustainability standpoint.Data and MethodologyMeyer (2002) indicated, “Measuring financial sustainability requires that MFIs maintain good financial accounts and follow recognized accounting practices that provide full transparency for income,expenses, loan recovery, and potential losses.” One of the biggest problems in conducting this kind ofstudy with MFIs in India is that for want of mandatory disclosure requirements and lack of dedicatedlegislation governing MFIs; it is very difficult to get reliable and actionable data on the financials. Onthe lines of MIX and rider attached by foreign donors on the MFIs to seek voluntary disclosure before theycan be considered for grants, some of the Indian MFIs have started to report their financials to MIX(www.mixmarket.org). By far Mix Market is most reliable database currently available on MFIs. Mixmarket has a system of classifying the reporting firms into star categories. This ranges from one to fivestars. This is based on their level of disclosure, vintage, quality of disclosure, financial parameters etc.Out of over a hundred MFIs currently reporting to Mix Market, we have chosen only five star ratedMFIs. They are 22 in number.Thereafter their financial performance has been compared on 22 different ratios. These ratios havebeen chosen again from the reporting format of Mix Market. The reporting format broadly analyzes thecompanies on six parameters of financial performance:1. Financial Structure2. Revenue3. Expenses4. Efficiency39